Commentaries (some of them cheeky or provocative) on economic topics by Ralph Musgrave. This site is dedicated to Abba Lerner. I disagree with several claims made by Lerner, and made by his intellectual descendants, that is advocates of Modern Monetary Theory (MMT). But I regard MMT on balance as being a breath of fresh air for economics.

Sunday, 30 March 2014

The “loans create money” brigade have
got all excited over the last two weeks or so as a result of this
Bank of England publication which says that loans create deposits / money.

Actually the cause effect relationship
runs both ways. That is, the commercial bank system cannot lend an extra £X
unless someone or a collection of people are prepared to deposit approximately
£X in the commercial bank system. That is, the relationship between depositors
and borrowers is a bit like the relationship between apple growers and apple
consumers: the market price for apples is not determined exclusively by buyers
or sellers.

Or as Nick
Rowe put it, “And commercial banks, neither individually nor collectively,
can create loans, unless they can persuade people to hold their deposits and
not hold central bank money instead.”

At least the latter point by Nick is
right if the economy is at capacity. That is, in the latter scenario, if
commercial banks did simply credit the accounts of borrowers without bothering
to see if they had enough depositor money, the result would be increased
aggregate demand. That is, the fact of failing to “persuade people to hold
their deposits” would mean that those depositors would try to spend away their
increased stock of money, thus demand would rise, which would be inflationary,
which the central bank / government would counter, e.g. by raising interest
rates or increased taxes. Result: no extra borrowing.

In contrast, if the economy is BELOW
capacity, lending money into existence with the resulting depositors trying to
spend away their new stock of money would increase demand. But that wouldn’t
matter to the extent that extra demand was called for.

Saturday, 29 March 2014

A system in which there are
commercial banks but no central bank would work without any big problems, far
as I can see. Obviously there’d need to be some generally agreed money unit,
e.g. a gram of gold, to start with. But once the system was up and running, the
relevant country could abandon the “gold standard”.

As to settling up between themselves,
commercial banks would not have the convenience of using central bank money.
But that wouldn’t matter too much. First, they’d just let inter-bank debts
stand for longer in the hope that those debts were eventually wiped out by
countervailing debts. Indeed, even under the existing system, i.e. where there
IS A CENTRAL BANK, commercial banks don’t always settle up inter-bank debts
immediately. Second, there is no limit to the number of assets that can be used
to settle up: shares, bonds, property, etc.

It’s possible that in a “commercial
bank only” system, and absent a gold standard, banks would lend too much and
bring hyperinflation, but that’s not what I want to concentrate on here.

Rather, the point I want to make is
that money creation by commercial banks is inherently expensive, compared to
central bank money creation. That is, to monetise an asset, a commercial bank
has to check up on the value of the asset, and that involves significant costs.
Plus there is the risk that something goes wrong, e.g. the person depositing the
asset / collateral might be a fraudster and doesn’t actually own the asset. The
bank has to insure against that risk.

In contrast, once a central bank is
established, and everyone accepts that it issues money in a reasonably
responsible way, the cost of creating and spending that money into the economy is
next to nothing. And even when government is an IRRESPONSIBLE issuer of money,
as used to be the case with Robert Mugabe, people will still use the government’s
money until levels of inflation become totally absurd, at which point (as was
the case in Zimbabwe) people will start using some other currency (US dollars
and South African Rands in the case of Zimbabwe).

___________

P.S. (31st March 2014). My
above claim that central bank money creation is more efficient that commercial
bank money creation begs the question as to why commercial banks manage to
compete with central banks. That is, how come commercial banks manage to create
money at all?

One answer is that central banks
create an inadequate amount of money, which leaves room for the
“counterfeiters” so to speak. A classic example of this is taking place right
now in the UK. That is, politicians and half the economics profession cling to
the daft notion that a deficit leads to increased national debt, and thus that
we have to be ultra cautious with deficits. As I’ve pointed out a trillion
times before on this blog, Keynes stated quite rightly that a deficit can be
funded either by debt or new money. But the latter ignoramuses immediately start
changing “inflation” as soon as the words “print” and “money” appear in the
same sentence. But for some bizarre reason they think that private bank lending
/ money creation WON’T BE inflationary.

The latter delusion is in overdrive
mode just at the moment in the UK in that politicians and economically
illiterate economists are having a nervous breakdown about the deficit, while
doing all they can to encourage excessive private bank lending: “funding for
lending”, “help to buy”, etc.

I particularly like this passage from
the letter: “A frequent question is: “Look at the size of the debt – how on
earth are they going to finance it?” One could just as easily ask: “Look at all
those savings in Japan – where on earth are they going to invest that?”

The letter also advocates what it
calls “sectoral flow of funds analysis”: another tool that MMTers are keen on.

In fact money deposited at the UK’s “National
Savings and Investments”, which is a sort of publicly owned savings bank, is
all invested in government debt. Now if you ask people if a rise in sums
deposited at NSI is beneficial, all else equal, they tend to answer “yes”. I
know, because I’ve asked several people.

But if you ask them whether a rise in
government debt is beneficial, all else equal, they almost invariably say “no”.

Thursday, 27 March 2014

As an advocate of much higher bank
capital ratios (and preferably a 100% ratio) I’m always much encouraged by the incompetence
of those who argue against higher capital ratios.

Douglas J.Elliot tries to argue in
this Brookings Institution article
that improved bank capital ratios would come at a cost.

His first argument is that “interest
payments on debt are tax-deductible while dividend payments on common stock are
not.” Thus if banks had to have more capital, that would raise their costs.
Well the flaw in that argument should be obvious: tax is an ENTIRELY ARTIFICIAL
imposition. It has precisely and exactly nothing to do with underlying REAL
COSTS.

I shouldn’t have to illustrate that
point because it should be obvious, but evidently I’ll have to, so here’s a
nice simple illustration that even those who write for the Brookings
Institution will hopefully understand.

If government taxed red cars more
heavily that blue cars,that would raise the retail price of red cars. But that
would not be evidence that the REAL COST of producing red cars was any more
than the cost of blue cars. Hope that’s clear now.

But I’ve got good news for Douglas
J.Elliot: I’ve come across more than one other so called “economist” who
doesn’t get the point that the change in price brought about by a tax is an
entirely ARTIFICIAL change in price.

Point No.2: TBTF.

Elliot’s second point makes the same
mistake as above first point. That is, he argues that where a bank is funded by
debt, the bank is not charged as much as it should be for that debt since the
relevant creditors know or suspect they are protected by the Too Big To Fail
subsidy. So to that extent, having banks funded by capital rather than debt
would raise bank costs.

Well of course! But there again, the
TBTF subsidy is ENTIRELY ARTIFICIAL. It does not reflect REAL UNDERLYING costs.

Bizarrely, Elliot actually concedes the
point that TBTF and other bank subsidies are an entirely artificial
contrivance. He says “Advocates of higher capital correctly point out that
these subsidies represent policy distortions and ought to be done away with..”
But for some reason he still clings to his claim that deposits are an
inherently cheaper method of funding a bank than capital.

Third: asymmetric information.

Elliot then claims that since
management knows more about a bank than potential purchasers of its shares, and
because management is likely to be overoptimistic about the bank’s prospects,
potential share buyers will want a discount when a new issue of shares is
offered. Thus, so he argues, having depositors fund a bank is an inherently
cheaper method of funding.

Well the first answer to that is that
is “bonds”. Bonds are a sort of compromise between shares and deposits. That
is, like deposits, a bank’s liability is fixed in dollar terms in the case of a
bond. But like shareholders, bond holders are not the most senior type of
creditor. And when a bank issues bonds, exactly the same “assymetric” point
applies: that is, potential bond holders want a discount.

As to depositors, one important
reason they don’t demand a discount when supplying a bank with funds is that
most depositors are protected by taxpayer funded guarantees: again an entirely
ARTIFICIAL contrivance.

A second reason depositors don’t
demand a discount is that they are senior creditors. But of course it’s
nonsense to deduce from that that funding a bank almost entirely via depositors
is therefore an inherent cheaper method of funding. Reason is that the higher
the proportion of a bank’s creditors that are made up of depositors, the less
the significance of the word “senior”. To illustrate, if 99.9% of a bank’s
creditors are depositors and 0.1% are shareholders, then the word “senior” is
almost meaningless. Who are depositors senior to? Almost nobody!!

Conclusion.

Given the poor quality of Elliot’s
first three arguments against higher capital ratios, I can think of better
things to do than examine his fourth, fifth and sixth reasons.

Non-peer reviewed (or only lightly peer reviewed) publications. The coloured clickable links below are EITHER the title of the work, OR a very short summary (where I think a short summary conveys more than the title).

i) The above is not a complete list in that earlier versions of some papers have been omitted. For a more complete list see here, and “browse by author” (top of left hand column).

ii) 7 deals with a wide range of alleged reasons for government borrowing, including Keynsian borrow and spend. 6 is an updated version of the "anti-Keynes" arguments in 7. 5 is an updated version of 1, which in turn is an updated version of 4.

______________

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Bits and bobs.

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As I’ve explained for some time on this blog, the recently popular idea that “banks don’t intermediate: they create money” is over-simple. Reason is that they do a bit of both. So it’s nice to see an article that seems to agree with me. (h/t Stephanie Schulte). Mind - I've only skimmed thru the intro to that article.________

Half of landlords in one part of London do not declare rental income to the tax authorities. I might as well join in the fun. I’ll return my tax return to the authorities with a brief letter saying, “Dear Sirs, Thank you for your invitation to take part in your income tax scheme. Unfortunately I am very busy and do not have time. Yours, etc.”________

Simon Wren-Lewis (Oxford economics prof) describes having George Osborne in charge of the economy as being “similar to someone who has never learnt to drive, taking a car onto the highway and causing mayhem”. I’ll drink to that.

Unfortunately SW-L keeps very quiet, as he always does, about the contribution his own profession made to this mess. In particular he doesn’t mention Kenneth Rogoff, Carmen Reinhart or Alberto Alesina – all of them influential economists who over the last ten years have advocated limiting stimulus (because of “the debt”) if not full blown austerity.________

Plenty of support in the comments at this MMT site for the basic ideas behind full reserve banking, though the phrase “full reserve” is not actually used.________

Old Guardian article by Will Hutton claiming the UK should have joined the Euro. Classic Guardian and absolutely hilarious.________

One of the first “daler” coins (hence the word “dollar”) weighed 14kg.!!! Imagine going shopping for the groceries with some of those in your pocket, or should I say “in your wheelbarrow”. (h/t J.P.Koning)________

Moronic Fed official reveals that GDP tends to rise when population rises. Next up: Fed reveals that grass is green and water is wet….:-)________

Fran Boait of Positive Money says the Bank of England "has no capacity to respond to a future crisis, and that puts us in an extremely dangerous position." Well certainly there are plenty of twits at the Treasury and at the BoE who THINK responding will be difficult. Actually there's an easy solution: fiscal stimulus, funded (as suggested by Keynes) by new money. Indeed, that’s what PM itself advocates. But it’s far from clear how many people in high places have heard of Keynes or, where they have heard of him, know what his solution for unemployment was.________

The US debt ceiling has been suspended or lifted 84 times since it was first established. You’d think that having made the Earth shattering discovery 84 times that the debt ceiling is nonsense, that debt ceiling enthusiasts would have learned their lesson, wouldn’t you? I mean if I got drunk 24 times and had 24 car crashes soon afterwards, I’d probably get the point that alcohol causes car crashes…:-) As for getting drunk 84 times and having 84 car crashes, that would indicate extreme stupidity on my part. No?________

The US Treasury has the power to print money (rather in the same way as the UK Treasury printed money in the form of so called “Bradburies” at the outbreak of the first World War).________

“Payment Protection Insurance” was a trick used by UK banks: it involved surreptitiously getting customers to take out insurance against the possibility of not being able to make credit card or mortgage payments. UK banks have been forced to repay customers billions. But that’s just one example of a more general trick used by banks sometimes called “tying”: forcing, tricking or persuading customers to buy one bank product when they buy another. More details here on the Fed’s half-baked attempts to control tying in the US.________

The farcical story of economists’ apparent inability to raise inflation continues. As I’ve long pointed out, Robert Mugabe knows how to do that. In fact Mugabe should be in charge of economics at Harvard: he’d be a big improvement on Kenneth Rogoff, Carmen Reinhart and other ignoramuses at Harvard.________

I’ve removed comment moderation from this blog. The only reason I ever implemented it was so as get rid of commercial organisations advertising something and posing as commenters. When doing that I noticed comments were limited to people with Google accounts for some strange reason. Removed that as well. ________

Article on money creation by Prof Charles Adams, who as far as I can see is a professor of physics at my local university – Durham. I can’t fault the first half of his article, but don’t agree with the second half which claims both publically and privately issued money are needed because we have a public and private sector. I left a comment.

Adams is nowhere near the first physicist to take an interest in money creation. Another is William Hummel. These “physicist / economists” are normally very clued up (as befits someone with enough brain to be a physicist).________

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MUSGRAVE'S LAW SOLVES THE FOLLOWING PROBLEM.

The problem. Deficits and / or national debts allegedly need reducing. The conventional wisdom is that they are reduced by raising taxes and / or cutting government spending, which in turn produces the money with which to repay the debt. But raised taxes or spending cuts destroy jobs: exactly what we don’t want. A quandary.

The solution. The national debt can be reduced at any speed and without austerity as follows. Buy the debt back, obtaining the necessary funds from two sources: A, printing money, and B, increasing tax and/or reduced government spending. A is inflationary and B is deflationary. A and B can be altered to give almost any outcome desired. For example for a faster rate of buy back, apply more of A and B. Or for more deflation while buying back, apply more of B relative to A